A Retirement Savings Cure-All?

By Catey Hill

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DIY retirement plan enrollment is out. Employers automatically enrolling employees in their plans is in. And that may be good news for investors, as experts credit the uptick in employers automatically enrolling employees in their 401(k) plans with better-allocated portfolios and more people contributing to their plans. But is automatic enrollment the cure-all that it seems?

While it may seem a bit Big Brother-ish to some, more companies are taking the choice of whether to enroll in their 401(k) out of employees hands. Whereas less than one in four employers automatically enrolled employees into their plan in 2006, three in five did it in 2010, according to a study from Aon Hewitt, which surveyed more than 120 large companies and 3 million employees. And it’s this auto-enrollment, experts say, that’s helping spur two trends — higher rates of participation in 401(k) plans and better allocated investments.

First, research shows that auto-enrollment increases participation rates. Eighty-five percent of employees who were subject to auto-enrollment contributed to the plan, whereas just 67% of employees who weren’t subject to it did, the Aon Hewitt study revealed. And now, more than 75.8% of eligible employees are contributing to their company’s retirement plan, the highest rate on record since Aon Hewitt began recording the data in 2002. Furthermore, auto-enrollment and high contribution levels have a cause-and-effect relationship: “This record-high participation rate is due in large part to the rapid adoption of automatic enrollment,” the Aon Hewitt study concluded.

Auto-enrollment is also spurring better asset allocation among younger investors, according to a new Vanguard study. Equity allocations for the average 20-year old have increased two-fold in the past seven years, from 40.7% in 2003 to 84.7% for a 20-year-old in 2010; those 30 and under also had a significant, though less dramatic, increase equity allocations over that period, says John Ameriks, a principal at Vanguard. This uptick in the percentage of equity ownership — which puts these investors more in line with suggested allocations (many advisers say investors should have a percentage of equities in their portfolio equal to 120 minus their age) — is largely a function of the increase in automatic enrollment, and the corresponding default investments, says Americks. Vanguard’s records show that at the end of 2010, of the 61% of plans that had a default investment choice, 89% of them had chosen target date funds as their default. So, when a young investor is automatically enrolled in a plan, their default investment would be a target-date fund, which would put a high portion of their savings into equities.

Of course, this doesn’t mean that auto-enrollment is a cure-all for our retirement woes. For one, employees who were automatically enrolled in a retirement plan saved an average of 6.8% of their pay, compared to 7.8% for those who actively enrolled, according to the Aon Hewitt study — a fact the company attributes to the low default rates among most employers. (More than three in four plans set default contribution rates at 4% or less.) Plus, employees still aren’t saving enough for retirement, despite this uptick in auto-enrollment. Even though 401(k) balances hit a record high this year — the average balance was $74,900 at the end of the first quarter, up 12% in the past year alone, according to Fidelity Investments — they’re still far smaller than experts recommend. (Consider that you may need 85% of your pre-retirement income to retire at the lifestyle you’re accustomed to.) And many times, the default investments have high fees or aren’t right for certain investors.

Still, the higher participation rates and better asset allocations for younger investors are heartening to many experts. Readers, what do you think? Are you in favor in auto-enrollment?

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About Encore

Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.